1. An investor is considering of constructing a portfolio by investing in a Currency Swap Hedge Fund (CS) and a Sovereign Default Swap Fund (SD).

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EC7092

All Candidates

Summer Examinations 2018

DO NOT OPEN THE QUESTION PAPER UNTIL INSTRUCTED TO DO SO BY THE CHIEF INVIGILATOR

Department School of Business Module Code EC7092 Module Title Investment Management Exam Duration (in words) Two Hours

CHECK YOU HAVE THE CORRECT QUESTION PAPER Number of Pages Three Number of Questions Six

Instructions to Candidates

Answer ALL Questions from Part A and ONE out of three Questions from Part B Each question from Part A carries 20 marks. Each question from Part B carries 40 marks. FOR THIS EXAM YOU ARE ALLOWED TO USE THE FOLLOWING:

Calculators Permitted calculators are the Casio FX83 and FX85 models

Books/Statutes provided by the University

No

Are students permitted to bring their own Books/Statutes/Notes?

No

Additional Stationery No

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SECTION A

Answer ALL questions. Each question carries a weight of 20 marks.

1. An investor is considering of constructing a portfolio by investing in a Currency Swap Hedge Fund (CS) and a Sovereign Default Swap Fund (SD). The coefficient of correlation between the two funds returns is estimated to be −0.2. The expected return and the standard deviation for each fund appear in percentage points on the table below:

Expected Return Std Dev of Returns CS 18% 15% SD 30% 22%

a. Suppose that the investor requires a 27% return on her portfolio, and that it is efficient. What must be the investment proportions of the two funds in the portfolio? What is the standard deviation of the overall portfolio? (7 marks)

b. What are the investment proportions of the two funds in the Minimum- Variance portfolio? What are the expected return and the standard deviation of the Minimum-Variance portfolio? (7 marks)

c. Allowing for short sales, find the equation of the efficient frontier that can be created by combining these two assets. (6 marks)

2. The expected return on the market portfolio is E(RM)=20% and its standard deviation

is σM =5%. The return on the risk free asset is RF=2%. a. Based on the CAPM, calculate the required expected return on assets A and

B, with corresponding betas: βA= -0.06 and βB= 1.2. (10 marks) b. Suppose there is no risk free asset, but there exists an asset Z that has

perfect negative correlation with the market portfolio, that is ρZM= -1. Z’s expected return is 7% and its standard deviation is 3%.

i. Is it still possible to calculate the required returns on the two assets and why? (5 marks)

ii. What are the required returns on assets A and B under this scenario? (5 marks)

3. The stocks of companies that produce self-driving cars currently provide an expected

rate of return of 20%. Goonter, a large company in this sector, pays a year-end dividend of £9 per share.

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a. If the stock is selling at £300 per share, what must be the market’s expectation of

the growth rate of Goonter dividends? (10 marks)

b. If dividend growth forecasts for Goonter are revised downward, so that the new projected growth rate for the company is g’=10% per year, what will happen to Goonter’s stock price? What will happen to the company’s price-earnings ratio? (10 marks)

SECTION B Answer ONE of the following questions. Each question carries a weight of 40 marks. If you answer more than one question, only the worst answer will be credited to you.

4. Prove that in the case where there are multiple financial assets, maximising the Sharpe ratio with respect to portfolio weights leads to the weights on the optimal risky portfolio being equal to:

𝑋𝑶𝑹𝑷 = 𝚺!𝟏(𝑹!!!𝟏) 𝟏!𝚺!𝟏(𝑹!!!𝟏)

5. Under what conditions is the mean-variance (or mean-standard deviation) approach legitimate in the process of determining the optimal portfolio for an investor?

6. If you were a hedge-fund manager, what arguments would you use to convince your prospective clients to invest in your company rather than pursue a passive investment strategy?

END OF PAPER